Treatment of transport, insurance and handling expenses
SARS issued a draft binding general ruling on 10 February 2017 in order to provide clarity on the treatment of expenditure incurred in respect of transport, insurance, and handling of refined and unrefined minerals for purposes of sections 5(3)(c) and 6(3)(a) and (b) of the Mineral and Petroleum Resources Royalty Act No 28 of 2008 (“the Royalty Act”), respectively.
The draft ruling has been issued in light of recent queries raised by SARS on taxpayers in the mining industry which are extractors of mineral resources and subject to royalty tax. SARS has been challenging the treatment of transport, insurance and handling costs in the determination of gross sales specifically.
Gross sales for purposes of sections 6(3)(a) and 6(3)(b) of the Royalty Act is to be determined without regard to any expenditure incurred in respect of transport, insurance and handling of a mineral after that mineral was brought to the condition specified in either Schedule 1 or 2 or to effect the disposal of that mineral resource. Earnings before interest and tax (“EBIT”) is to be determined on a similar basis, i.e. without regard to transport, insurance and handling costs after that mineral was brought to the condition specified in Schedule 1 or 2, or to effect the disposal of that mineral resource.
In the draft ruling, SARS sets out the meaning of the phrase “without regard to” and refers to case law as the phrase is not defined. SARS notes that when one considers the context in which the phrase “without regard to” is contained, the appropriate dictionary meaning would be “disregarding” or “disregard”, therefore to exclude or ignore something. It is then stated that “it does not imply that there must be a deduction in respect of transport, insurance and handling expenses that have been incurred after the mineral resources is brought to the condition specified or to effect the disposal of that mineral resource”. It is then concluded in the ruling that the ordinary dictionary meaning of the phrase “without regard to” means that the expenditure in respect of transport, insurance and handling after the mineral is brought to the condition specified in Schedule 1 or 2 or to effect the transfer of the mineral, must not be taken into account when determining gross sales and EBIT for purposes of calculating the royalty percentage. Such costs will not qualify as a deduction in the determination of gross sales or EBIT.
SARS makes reference to the interpretation the courts placed on the phrase “have regard to” in Joffe and Another v Commissioner of Child Welfare, Springs 1964 (2) SA 506 (T). In our view, applying this interpretation directly to the phrase in sections 5(3)(c) and 6(3)(a) and (b) of the Royalty Act results in an absurd and unintended result which contradicts the purpose of the royalty tax, the purpose which is ultimately to tax the extraction of mineral resources in South Africa.
The ruling further recognises that such costs may be on-charged and included in the price of the mineral resource sold and that the sale price may be adjusted to disregard such amounts from the calculation of gross sales and EBIT, but the onus will rest on the extractor to prove the inclusion of the amounts in the price of the mineral resource sold.
The ruling does not seem to take into account the various sales delivery terms (Incoterms) used for the transportation of resources. These Incoterms are very often embedded in the sales contracts and used for price negotiation almost always. Recovery of these costs should not be subject to royalty tax.
Sections 5(3)(c) and 6(3)(a) and (b) of the Royalty Act clearly contemplates two scenarios in the calculation of gross sales and EBIT, one of which is expenditure incurred to effect the disposal of the mineral resource. As long as there is a causal connection between the expenditure incurred and the disposal of the mineral resource, the requirements for exclusion under the said sections should be met. There should not be any further test or requirement. The ruling seems to suggest a new requirement in that extractors needs to evidence the inclusion of amounts in gross sales, which goes further than a mere causal connection.
The 2008 Explanatory Memorandum to the Royalty Act states that with regards to the exclusion of transportation, insurance and handling costs from the calculation of gross sales and EBIT, that the exclusion is necessary “to as not to penalize minerals that are located far from markets or an export port”.
Will the interpretation by SARS of the phase “without regard to” as set out in the draft ruling, not exactly result in penalizing extractors on the transport of mineral resources?
Comments on the draft ruling is due to SARS on 10 March 2017.
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